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07/19/2009

How Should Universities React to the Decline in Their Endowments? Becker

The values of most university endowments have taken large hits during this financial crisis. The average decline since the real estate and stock market crashes began is probably over 20%, while the value of some endowments dropped by much more than that. Universities reacted to this severe shock with panic, and they often reduced their spending by too much.
I say "by too much" not because of any confidence that stock markets and real estate will return any time soon to their peak values. This is highly unlikely for real estate, and dubious for stock markets. My reason for objecting to large cuts in university spending is that they have usually under spent relative to their endowments. The philosophy behind these spending rates is that universities should not live off of capital, so that they can pass their capital intact on to future students and faculty. In order to preserve endowment values for the future, universities have tried to spend from their endowments only the income yielded, including capital gains, adjusted for year-to-year fluctuations in returns, and for other risks. On average, they have spent between 4% and 6% of their endowments.
This philosophy has not been implemented, if by not living off capital is meant that endowment values would be held rather constant in the long run. For endowments at all the major universities, and many other schools as well, have grown at very good rates during the past 40 years rather than being maintained intact. For example, Harvard's endowment increased many fold from 1960 to its peak at well over $30 billion in the fall of 2008. The University of Chicago was much less successful in its investment and gift-raising strategies than Harvard, but even the value of Chicago's endowment more than trebled from 1960 to its peak in 2008.
University spending has been too little to maintain endowment values constant partly because the annual return on their endowments has been underestimated, and partly because of large annual gifts from alumni and foundations that raised endowments. These gifts were especially big during the past decade as stocks soared, and as financial executives and others received generous bonuses and stock options, but they have not been negligible even during more normal times.
If we conservatively assume that gifts double endowments over 40 years, than in order to account for gifts and maintain endowment values, schools should spend 1 ¬æ percent of their endowments in addition to the total incomes yielded by the endowment. Since incomes have averaged over long time periods at about 5-6% of endowments, the additional spending that would tend to keep endowments constant would raise endowment spending by more than one third. This means a very a large increase in total spending for schools like Harvard that get a big fraction of their annual revenue from endowment income. The percentage increase in spending would be significant but smaller for schools like Chicago that are less well endowed, and get a larger fraction of their revenue from tuition and grants.
More fundamentally, the argument that universities should try to maintain a constant, or "sustainable", endowment value is flawed and not compelling for reasons similar to the criticisms of proposals to maintain an economy's capital over time to achieve "sustainable" economic development. Why should schools aim to maintain endowments constant when even aside from private gifts, endowment income provides only a fraction of their annual revenue? Moreover, technological improvements in the efficiency of spending, by schools, such as more effective use of internet learning, may allow smaller endowments in the future to achieve as much in educating students and conducting research as larger endowments do now.
Another reason for spending more out of endowments than the income yielded is that effective spending on training of students and research, and often also spending on sports, are frequently productive in stimulating greater gifts and governmental grants. For example, schools that produce pioneering research, or that attract able and ambitious students who go on to achieve great success, tend to get larger amounts of foundation and other gifts through the favorable publicity they receive. In effect, spending is productive not only in raising student and faculty achievements, but also indirectly in inducing greater gifts that can lead to even greater accomplishments in the future.
In recent years members of Congress have proposed forcing universities to spend a larger fraction of their endowments, so that endowments do not increase as rapidly as in the past. It would not be wise for Congress to get involved in university spending rates, but for the reasons I have given, it is in the self-interest of well-run universities to spend at much higher levels than they have been doing during the past several decades.

Comments

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Let's keep Congress out of this one. The problem has outraced any sensible national legislative solution. Endowment/trust managers are between a rock and a hard place. Sure, the supported institutions need a boost in current revenue. But if you're Daddy Morebucks in this investment climate you don't want to liquidate the positively-performing investments you still hold; liquidating more of your losers will make YOUR performance (and bonus prospects) look poor; and you've probably taken aboard a load of "alternative" assets - e.g., PE interests, hedge funds, CDOs, MBSs - you can't fairly value except by looking at the rating agencies' downgrades. On top of that, some of these money pits may have their mitts in your funds for capital cash calls on limited partners. I've read that the dynasty Ivy League endowments are wrestling with such exposures.

I know a VFW post or two - survivors of the Great Depression, WW II, and Korea - who could put real solutions into action if they had the invitation. But they won't get it. They'll just keep dying. The best & brightest to whom they handed off the blessings of liberty preserved have failed us miserably.

You and Judge Posner make excellent points about the supposed ‚Äúcrisis‚Äù in university endowments that has led one wealthy school after another to freeze hiring, stop construction projects, and slash spending. It is also worth pointing out that although losses of 20 or 30 percent sound terrible, in fact many of the largest university endowments are back now to the price-adjusted levels that they reached as recently as four or five years ago, as some presidents such as Rick Levin of Yale and Ruth Simmons of Brown have admitted.

The principal justification for endowment is its value in cushioning the effects of a drop in revenue or an unexpected and unavoidable increase in expenses‚Äîthat is, as a rainy day fund (as argued in our recent book, Mission and Money: Understanding the University, coauthored with Jeffrey Ballou). We took as an example the actual rainy day that hit schools in the Gulf due to Hurricane Katrina in 2005. Tulane‚Äôs revenue dropped by 10 percent that year. So if a school used money from its endowment to offset even a 10 percent revenue loss for a year, how many such rainy days could it withstand? We found that in Tulane‚Äôs case, its 2005 endowment of $780 million gave it a rainy day fund sufficient to make up for the 10 percent drop in revenue for 13 consecutive years. That is, the ratio of its endowment to 10 percent of its annual expenditures was 13.

Other schools have much larger rainy day funds. According to our calculations Princeton as of 2006 could last for 141 years spending only from its endowment, Harvard for 141 years, Stanford for 53 years, Chicago for 26 years, but tiny Grinnell could go an astounding 191 years.

How much endowment is enough? Endowment managers and their university administrations have acted as it the endowment should always grow and never be spent down. We agree with you that colleges and universities should be spending more of their endowment rather than making spending cuts. The rainy day that the schools have been saving for all these years is here!

one manner in which the universities have responded is to once again raise tuitions, quite incredibly, in this market. During good times, they all raise tuitions at rates exceeding the consumer index. And during bad times they do the same. I realize that the expression of something with an inelastic demand curve may be somewhat reinforcing to the schools, but the adverse impact on students carrying a huge, and growing larger, debt load cannot be good.

In the 19th century, several so called ‚ÄúRobber Baron‚Äù philanthropists, (who were neither robbers nor barons), set up enormous endowments for many of our larger universities‚Äîthis with the intention of enhancing the educational level of our nation. These people understood that the success of a nation depends largely on the critical thinking skills of its populace. They also understood that if change was to happen, it was up to them, as individual actors, to make it happen. They knew that money speaks‚Äîand that it can speak for the benefit of humankind. They knew of a truth, that humankind has a bright future.

They believed in science. They believed that A is A. They believed in the law of identity‚Äîthat a thing is itself, and that all things, and persons, have properties that can be used by the sensitive person to define who and what that are. They understood that life is independence and individual understanding‚Äîthese are the product of a true education. These so called ‚ÄúRobber Barons‚Äù were able to grasp these facts because they themselves were holdovers from the enlightenment. (They would have been more comfortable in the company of Voltaire or Diderot than of Nietzsche or Marx.) These ‚ÄúRobber Barons‚Äù understood that training in "sensitivity," meant schooling in the nuances of life‚Äînot in the skills of a coercive bludgeoning polemics of ‚Äúpolitical correctness.‚Äù

By whatever means the market flushes out bad ideas‚Äîthe chain is nevertheless pulled and the refuse is washed away. The internet, self-education, diverse private approaches, and for-profit private education are the wave of the future. Education is truly as it has always been, a private and individual affair‚Äîas it was in Aristotle‚Äôs time. Teachers teach and students learn.

The true academy no longer resides in our universities. It may not be a bad thing if they lose their endowments and close altogether--then again it may be if the likes of Plotinus, Irenaeus and Augustine make the scene again. Its time our "educational" institutions woke up to what they're doing. Seems that's what's already going on in the middle east. Seems were not that far behind.

The post on university endowments by Prof. Becker, usually a tireless defender of economic liberty, is a disappointment to the extent he suggests the trustees of an endowment fund should be allowed to invade endowment principal by spending more than the income that principal generates. An endowment fund is not like a hedge fund, and the folks who put their hard-earned money into an endowment fund have every right to expect that their money will serve the directed purpose(s) unto perpetuity.

Dr. Becker says "the value of Chicago's endowment more than trebled from 1960 to its peak in 2008."
But the CPI-U was 29.6 in 1960 and 215.3 in 2008. That's a 7.3 times increase in prices. So it looks like Chicago's endowment has decreased, not increased, over this period. A reasonable target might be to keep endowments roughly constant when adjusted for purchasing power.

Not to worry. When Obama gets through, everyone will be guaranteed a college education so there won't be any need for endowments. Isn'th that what he has said. AND all of the colleges will have to have the same buildings and functions, sort of like a soviet apartment block.

"Education is truly as it has always been, a private and individual affair‚Äîas it was in Aristotle‚Äôs time. Teachers teach and students learn."

Ah yes, let's go back to when educations were only given to wealthy males of the ruling class, while their slaves worked in the fields and shops and women were excluded from learning. Nothing like the good old days. Just remember who Aristotle's most famous student was, Alexander the Great.

"AND all of the colleges will have to have the same buildings and functions, sort of like a soviet apartment block."

It's a sad state of affairs when two serious academics attempt to have a productive blog and it attracts the same people who troll foxnews.com.

To whoever posted to this blog as ‚ÄúPosted by Anonymous at July 23, 2009 12:49 AM,‚Äù

At the risk of being politically incorrect, let me just point out that you are an idiot. I don‚Äôt often come on that strong, but you attacked my posting as a desire to:

‚Äúgo back to when educations were only given to wealthy males of the ruling class, while their slaves worked in the fields and shops and women were excluded from learning. Nothing like the good old days. Just remember who Aristotle's most famous student was, Alexander the Great.‚Äù

You failed to realize the following:
1)The Academy, not even the one in Athen‚Äôs, was exclusively attended by ‚Äúwealthy men of the ruling class.‚Äù I will leave it up to you to actually study the history and philosophy you missed out on for whatever reason. (It is not my responsibility to educate you‚Äîor to pay for the farce of your ‚Äúeducation.‚Äù It is only my responsibility to see to it that people such as you are not given positions of responsibility or authority when my life or the lives of those I care about are on the line. People who wantonly refuse to take primary responsibility for themselves, and instead decide to blame others, are not to be trusted as the doctors who attend to me and mine, or even as the hamburger flippers who feed me and mine.)
2)The role of women, like that of everyone who has ever lived, has always been a nuanced one. Historically, many women are among the best examples of the power of self-education, especially in the light of institutional failure and indifference. (Again, my trying to inform you of the history of this point will be wasted as you have convinced yourself that I am merely some kind of a right-wing ideologue who only ‚Äútrolls foxnews.com‚Äù for his viewpoint. You need to grow up and get your own education. In nature, such affronts to others are usually handled in a particularly ‚ÄúDarwinian‚Äù fashion.)
3)You fail to see the classicism and sexism in your own comments. (Again, it is not my responsibility to render a content analysis of your statements, or the perspectives that underlie them. I will merely let you display your ignorance for the truly educated world to see and to draw its own conclusions. It is not my responsibility to sanction your motives by pretending to explain to you the errors of your sloppy thinking. It is only my responsibility, if I should choose to accept that responsibility, to point out to you that your thinking is sloppy. My responsibility lies in trying to protect myself as best I can from the creeping stupidity that is being inflicted on our society by people such as you.)
4)Obviously you believe that during most of history, educated people were only ‚Äúwealthy males of the ruling class.‚Äù This is a deeply limited ‚Äúvictim‚Äù perspective that can only disempower its holder. So, I can piss all over you, knowing that all you can ever do is wish for Jesus, Allah or some people‚Äôs revolution to save you from the big bad ‚Äúwealthy male of the ruling class.‚Äù

Incidentally, I‚Äôm not a ‚Äúwealthy male of the ruling class.‚Äù Only it‚Äôs just that long ago stopped drinking the cool aide you‚Äôve been guzzling.

I know your attack was merely some clever way of convincing yourself that you are smarter than the average bumpkin‚Äîbut I assure you that you are not. Get a mind and figure out how to think before you hurt yourself.

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Nexpider

Harvard's endowment increased many fold from 1960 to its peak at well over $30 billion in the fall of 2008. The University of Chicago was much less successful in its investment and gift-raising strategies than Harvard, but even the value of Chicago's endowment more than trebled from 1960 to its peak in 2008.
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